Samantha Obom graduated from the Nova Scotia College of Art and Design (NSCAD) w

Question

Samantha Obom graduated from the Nova Scotia College of Art and Design (NSCAD) with a Master of Fine Arts in craft. While she was completing her degree, Samantha sold her jewellery designs at the Halifax Seaport Farmers Market on Saturdays. Samantha’s designs are in great demand. Several of her customers suggested she open a combination retail store and design studio on the popular shopping street, Spring Garden Road, in Halifax so she would be more accessible to her customers and potential customers during the week. Samantha located suitable space and hopes to open Samantha’s Gems in two weeks. Her friends have told her she needs to set up an inventory system to track the raw materials and finished pieces of jewellery. Someone suggested that she needs to count her inventory but Samantha thinks it is a waste of time. She would rather spend the time designing and crafting. Samantha’s friends finally convinced her that she needs help with the inventory side of her business. During a recent meeting, Samantha provides you with the following information about the nature of her inventory.

Samantha attends the annual American Gem Trade Association trade show in Tucson, Arizona, where she buys precious and semi-precious gems for use in her designs. Prices for the gems range from $250 to over $1,000 depending upon the type, quality, and size of the stone. Samantha typically buys $25,000 of stones each trip.

Each gem is labelled as to cost, date of purchase, and relevant characteristics and is stored in a cardboard box on top of her design table in the new studio.

While moving into her new space, Samantha discovered that two of the turquoise stones in her inventory had small cracks. Total cost for the two stones was $495. Samantha thinks she can still use the stones but estimates the net realizable value is $350.

Samantha plans to hang the gold chains (14K and 18K) in a display case on top of the sales counter. During the move to her new space, Samantha discovered that she was missing three 18K gold chains.

There are several boxes of findings (small pieces required to assemble the jewellery) in the studio. Samantha normally buys the findings in bulk. The only distinguishing feature is the size of the finding.

Based on the information provided by Samantha, prepare a draft report that addresses the following questions:

* Should Samantha Gems use a periodic or perpetual inventory system? Consider the advantages and disadvantages of each one.

* What inventory cost formula should Samantha’ use? Consider the nature of the inventory.

* Explain the concept of net realizable value and how it applies to Samantha’s business.

* Explain why counting inventory is not a waste of time.

Explanation / Answer

Ans : 1

Samantha Gems as the name says deals with gems and precious stones in their business. As these stones and gems in which she is trading and doing business are precious and costly, and must be handled with care to avoid wastage and loss. Gems being as a part of inventory creates a concern for the gem trader or business person dealing with gem about there loss due to theft , misplaced, left accounted and many more. To avoid this he or she should choose a perfect inventory tracking system which would help him or her in getting traced and updated with the current stock of the gems in hand and its inflow and outflow. And this activity is possible only if continous tracking and updating of information in the system is done on daily basis with the count of inflow and outflow activities. Than is it possible to do it on daily basis ? I would say , yes!

Its possible with the help of Perpetual Inventory System. It is the best tool to get control over your inventory which is a crucial and sensitive part of any business. A perpetual inventory method is one whereby records of inventory held are maintained on a continuous basis. This provides a continuous record of the inward and outward movement of goods, so that the quantity and book value of the inventory which ought to be on hand may be seen by inspection of the record; in other words, a perpetual balance of inventories on hand is kept. The discrepancies between the two balances may be due to clerical errors, theft, wastage or other causes. Irrespective of the reason for the difference, the inventory records must be brought into arrangement with the physical inventory count and any discrepancies written off by charging them in the income statement according to the nature of the difference.

Instead , if she chooses to go for a Periodic Inventory System would it be right decision from her business perspective? I would say, NO!

Here is the reason why I would say No - When the periodic inventory system is employed inventory account is not debited or credited on account of purchase or sale of goods. Consequently, inventory is not determined through movements of purchases or sales rather it is determined through a complete physical inventory count only at the end of an accounting period or at specified intervals.

Looking at this will it be possible for her to look out and figure out the differences in inventory if found at the year end ? And plus bear the losses if any which are found to be non-traceable , No! Instead of taking such a big risk in business why go for what is profitable for her and her long run business. And that is Perpetual Inventory System.

Lets see advantages and disadvantages of Periodic and Perpetual Inventory system.

Advantages of Periodic Inventory System:

(i) Much time and even labor costs are saved as continuous records need not be maintained.

(ii) A generally simpler system to administer as compared with the perpetual inventory system.

Disadvantages of Periodic System:

(i) As inventory take generally involves additional time, cost and disruption to normal business routines. This usually prevents a physical inventory being taken more frequently.

(ii) As inventory value is only determined at the end of the period so there is very little control over inventory movements. The value of lost, stolen or spoiled goods therefore is difficult to ascertain. This may significantly affect profits and net worth.

(iii) Short term (monthly or quarterly) profit and loss statements cannot be prepared unless an inventory count is taken at the end of each period.

Advantages of Perpetual Inventory System:

(i) There is great control over inventories through periodical comparison of inventory records with physical inventory.

(ii) Short term financial statements can be prepared as the values of cost of sales and inventory balances are readily available.

(iii) The inventory ledger cards help to maintain optimum level of inventories, ensuring that the business is never out of inventory or have too much money tied up in inventories.

Disadvantages of Perpetual Inventory System:

(i) Continuous maintenance of record for inventory movements involves additional cost.

(ii) In case of use of a manual accounting system, maintenance of inventory ledger cards is a very time consuming job. However, this may not be such a disadvantage for firms with a computer.

Ans : 2 Samantha can either use FIFO or average cost valuation method. LIFO is not allowed as a measuremnent for reporting under IAS - 2. Hence, cannot be taken into consideration. Under the IAS 2 the formulas allowed are the first- in –first out method or the weighted average cost formula. When inventories are sold, the carrying amount of these inventories shall be recognized as an expense in the period in which the related revenue is recognized. The amount of any write-down of inventories to net realizable value and all losses of inventories shall be recognized as an expense in the period the write-down or loss occurs.

I suggest her to Go for FIFO method as it  results in the inventory account on the balance sheet having a value that most closely approximates current value.

Ans : 3 In the case of inventory, a company may find itself holding inventory that has an uncertain future; meaning the company does not know if or when it will sell. Obsolescence, over supply, defects, major price declines, and similar problems can contribute to uncertainty about the realization (conversion to cash) for inventory items. Therefore, accountants evaluate inventory and employ lower of cost or net realizable value considerations. This simply means that if inventory is carried on the accounting records at greater than its net realizable value (NRV), a write-down from the recorded cost to the lower NRV would be made. In essence, the Inventory account would be credited, and a Loss for Decline in NRV would be the offsetting debit. This debit would be reported in the income statement as a charge against (reduction in) income.

Samantha can apply net realization valuation method in the like situation which is given. In similar cases if there is obsolescence, over supply, defects, major price declines, and similar problem, she can estimate a selling price of the default product. NRV, in the context of inventory, is the estimated selling price in the normal course of business, less reasonably predictable costs of completion, disposal, and transportation. Hence, its the perfect way to valuation of such products.

Ans 4: Inventory counting is not a waste of time. This is true as inventory is the core current asset of every business on which it is able to conduct its business. Keeping an eye on the core current asset of the business is a mandatory part. Therefore counting the balance of the inventory not only checks the movement of inventory and the remaining balance of it but also gives us the balance as in date about the remaining balance of inventory and the restocking time for it.

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